WEEKEND ECONOMIST: A sentimental rate cut

A close look at this week's Westpac-MI consumer sentiment index and ABS unemployment data supports the case for two rate cuts in the next three months.

There has been considerable evidence from the April reading of the Westpac and Melbourne Institute index of consumer sentiment to support our case for two rate cuts in May and June-July.

The index fell by 1.6 per cent in April from 96.1 in March to 94.5 in April. The index is now at its lowest level since August last year when consumers were very concerned about the global outlook and warnings from the Reserve Bank and most commentators that higher interest rates were imminent. With conditions in the global economy improving and commentators interpreting the Reserve Bank Governor’s latest statement as hinting strongly that rates are likely to be cut next month it seems surprising that households would have a negative reaction in April. Indeed, apart from last year’s lows and the March 2008 to May 2009 period, when households feared a recession associated with the Global Financial Crisis, we have to go all the way back to 2001 following the bursting of the dot com bubble and the post-Olympics/post-GST slowdown to find sustained lower reads. From there we have to go all the way back to 1992 to find the next series of lower prints.

It is true that the Reserve Bank disappointed many in the first week of April by not delivering a much needed rate cut, but the guidance from the governor’s statement was quite encouraging. However, folks with a mortgage did not see it that way. Confidence of borrowers fell by 5.1 per cent compared to an increase in confidence of tenants of 7.4 per cent while those respondents who wholly own their houses saw a much smaller fall in confidence of 1.7 per cent. Over the last 12 months the standard variable mortgage rate has fallen by 0.4 per cent yet the confidence of respondents who hold a mortgage has fallen by 14.6 per cent.

Other factors that influence confidence appeared to have a mixed impact in April with the share market up 3.3 per cent; the Australian dollar down two cents against the US dollar and petrol prices up five cents to $1.50 a litre.

There is a very disturbing message in the movements of the components of the index. Two components measure respondents’ assessments of their own finances; two measure the outlook for the economy in general; and one looks at attitudes towards spending.

Respondents seem particularly perturbed about the state of their own finances. The sub-index tracking views on ‘family finances compared to a year ago’ slumped by 14.4 per cent and the subindex tracking expectations for ‘family finances over the next 12 months’ fell by 4.1 per cent. In contrast, the sub-indexes tracking views on ‘economic conditions over the next 12 months’ and ‘economic conditions over the next five years’ rose by 0.8 per cent and 1.5 per cent respectively. The sub-index on "whether now is a good or bad time to buy a major household item” rose by a solid 4.3 per cent.

Attitudes towards purchasing housing and motor vehicles deteriorated. The index tracking views on "time to buy a dwelling” was down by 0.3 per cent but at a relatively solid overall level while the index tracking views on "time to buy a vehicle” fell sharply by 4.9 per cent, possibly reflecting recent petrol price rises.

Respondents’ spending behaviour is likely to be considerably influenced by how they assess their own finances. As such, the very weak reads in April are of significant concern. Apart from the one observation in July 2008, when respondents were gripped with concerns over the Global Financial Crisis and mortgage interest rates hit 9.6 per cent, the read in the survey on their assessment of finances compared to a year ago is the lowest since the recession in the early 1990s. Their outlook for finances over the next 12 months is still better than during the July-August period last year; in July 2008; and readings a few months prior to the introduction of the GST in 2001, but apart from that we need to go all the way back to the early 1990s to see lower prints.

With fears of rising interest rates or a second global financial crisis having eased we can only conclude that concerns around job security; house prices; high debt levels; petrol prices; utility costs; and uncertainty around the imminent introduction of a price on carbon, are weighing heavily on households’ concerns about their financial position. It may be that there is a "non-linear" effect from concerns about both job security and housing.

Job concerns have eased, but only marginally

The Westpac-Melbourne Institute survey of unemployment expectations did ease 4.8 per cent in April following on from a 4.1 per cent rise in March and a 6.2 per cent rise in February. Remembering that a rise in this index suggests households are more negative on the jobs market, unemployment expectations are now 30.2 per cent higher than a year earlier. More critically, job expectations for those with mortgages or households with children have deteriorated significantly. The current level of expectations points to a soft jobs market and a rising rate of unemployment.

These developments do not appear to be consistent with the strong jobs report for March which printed an increase in jobs of 44,000. However, it is important to note that the unemployment rate did not fall.

It is useful to review the methodology of the Australian Bureau of Statistics (ABS) in arriving at these jobs figures. Firstly, the working age population is derived independently of the employment survey. The survey estimates the proportion of the population who are employed; are unemployed and looking for work; or unemployed and not looking for work. The number employed is estimated from the survey by grossing up the proportion of those in the employment survey that reported that they were employed by the ABS' estimate of the total working age population. The number of new jobs is the change in the estimate of employed from month to month. Consequently, a slowdown in the estimate of the growth in working age population will slow down the number of jobs added – that was certainly an important, but not the only, reason behind the lack lustre jobs growth in 2011.

The sharp increase in the number of jobs added in this report was matched by a 41,000 increase in the labour force so there was only a minor drop in number unemployed and looking for work. And of that 41,000 increase in the labour force, only 3,000 was due to growth in the working age population; the remainder came from folks who were described in the previous month as unemployed and not looking for work gaining work in March. You can also see this in the leap in the participation rate, which is simply the labour force presented as a share of working age population, from 65.2 per cent to 65.4 per cent.

Does it not look a little strange that 86 per cent of the new jobs were acquired by people who as recently as one month ago were so discouraged that they were not even looking for jobs? It is impossible to reconcile the 16,000 full-time jobs that were acquired from such a "standing start", unless it is assumed that those jobs were gained through existing part-time employees gaining full-time employment. But this would show up as a large rise in full-time employment (say plus 41,000 compared to the plus 16 thousand print), but if this was the case then we would have to assume all of the new jobs added were part-time positions thus holding the level of part-time employment constant in March. None of this happened.

This analysis just emphasises that it is the unemployment rate and not the number of jobs that should attract major attention when analysing the employment report. In that regard the unemployment rate fell from 5.24 per cent to 5.19 per cent, hardly a move to jolt us into thinking that the labour market has suddenly turned the corner.

Bill Evans is Westpac’s chief economist.

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